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ACC 522 Study Guide - Final Guide: Debenture, Term Life Insurance, Child Tax Credit

Course Code
ACC 522
Antoinette Vena
Study Guide

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Tax Exam
Chapter 7: Income from property
Income from property defined
- Generally defined as the return on invested capital where little or no time, labour, or attention has been
expended by the investor in producing the return
1. The return of dividend income on the investment in capital shares of public and private
2. The return of interest income on investments in bank deposits, loans, mortgages, bonds,
and debentures
3. The return of rental income on the ownership of real estate or other tangible property
4. The royalty income on the ownership of properties, such as patents and mineral rights
- Not include gain or loss resulted from sale on property = CG/CL
- Disposal = NOT property income
- Rental property sold = CG/CL, but CCA deducted to determine property income earned from rents=
recapture → property income and terminal loss→ property loss
- To qualify as property income, interest must be earned in a relatively passive way, w/o the commitment
of significant time, labour and attention by the owner
Interest income earned by a small/large financial institution ≠ property income, it is business
income b/c taxpayer must expend significant effort in order to generate that income
Income = business income and not property income wont change the income calculated with
some exceptions
General rules for determining property income
- Property income = net property income (rev-Exp)
- Expenses incurred to earn property income can be deducted for tax purposes provided that
They are incurred for the purpose of earning income that is taxable
They are not an expenditure of a capital nature, an expenditure on the account of capital, or
depreciation and amortization
They are not a reserve
They are not a personal or living expense
They are reasonable under the circumstances
- Property income and the taxation year
Taxation year for individual= calendar year, corporation= fiscal year
- The deduction of interest expense
Interest expense incurred on a loan used to acquire an investment = on account of capital →
exception to the general rule
Interest on loans used to purchase investments, such as bonds, bank certificates, share of
corporations and real estate, is deductible against the interest, dividends and rental income
When individuals are in the position to acquire both personal and investment assets, they
should apply these principles in order to maximize their after-tax CF:
oPersonal assets should, to the extent possible, be acquired with excess cash. Such
assets- cars, a house, a cottage, and the like-can then be used as collateral to obtain
loans for investment purposes
oWhen individuals have personal and investment loans, excess cash should first be used
to repay personal loans that are incurring non-deductible interest. It is important that
separate loans be arranged for personal use and investment use
The unique features of property income
- Interest income
Interest income = compensation received for the use of borrowed funds
Recognition of income

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oDifferent types of debt obligations require the pmt of interest to the creditor at different
oHow to tax on interest? Timing difference
oThe timing of income recognition for tax purposes is important b/c it affects the net after-
tax CF and, by extension, the yield on a particular investment
oAll corporations (private/public) must recognize income according to the normal rules for
profit determination and do so on an accrual basis
Corporations must include interest as income as it is earned on a daily basis
oIndividuals, unlike corporations, have at their disposal, within a certain time limitation, 3
methods for recognizing interest income:
Receivable method
Cash method
Anniversary day accrual method
oEx. One can use cash method for investment A and annual accrual method for
investment B
oReceivable method = interest is included in income only when the amount is legally due
and payable
Ex. Corporate bond paid semi-annually on june 15 n dec 15. If end of taxation
year = dec 31 and dec 15 interest is not received, it must still be included in the
year’s income b/c its legally due and receivable
oCash method= interest income is taken into income for tax purposes only if it has been
received by the individual in the year
oAnniversary day accrual method= requires interest income be recognized for every 12
month period from the date the investment was made
When an investment requires that interest be paid after a long period of time (≥ 1
Means that interest income recognition can be deferred for only a limited period
NOTE: individuals cant use the normal accrual method for accruing interest on a
daily basis, as can corporation and partnerships
Ex. Interest payable at the end of 2 years
Under special annual accrual method, interest must be recognized every
12 months from Feb 1,2011 until the end of the term of the loan
Feb 1,2011- Dec 31,2011 = NIL
Feb 1,2011- Jan 31,2012 = 12% x 100 000
Feb 1, 2012- Jan 31, 2013 = 12% x [100 000 + (12% x 100 000)]
Foreign Interest
oInterest earned on investment in a foreign country is recognized in terms of Canadian
oWhen foreign taxes are withheld from the payment, the full amount of interest, before the
amount is withheld, must be included in property income (Canadian tax on this foreign
income can be reduced thru foreign tax credit)
oTreat foreign tax as expense against property income = element of double taxation
Life insurance policies
oCertain life insurance policies include both a savings component and a life insurance
component (whole life insurance)
oOthers are designed solely to provide life insurance protection (term life insurance)
oLife insurance policy includes a savings element that accumulates interest returns
Must be reported annually, when exempted = combination of life insurance and
savings can amount to a significant long term tax deferral
Deductions from interest income
ob/c property income = “profit therefrom”, interest income calculated on a net basis (rev-
oExpenses incurred to earn income are:

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Interest exp on loans used to acquire interest bearing investments
Investment counselling fees
Costs incurred to obtain a loan (legal fees, mortgage appraisal fees, and
registration fees: amortized over 5 years at the rate of 1/5 per year)
Fees paid to managers of investment portfolios
Fees paid to a financial institution for holding securities (cost of a safety deposit
box is NOT a deductible)
Acc fees for record keeping and determination of income from property
Reserves/complete deductions for interest income that has been accrued but is
not collectible b/c debtor’s inability to pay
- Dividend Income
Dividends= returns provided on the investment in shares of a corporation; they reflect the
distribution of a portion of the corporation’s profits to the shareholders
Dividend income can be received by both corporations and individuals
Corporate earnings are taxed in the hands of the shareholder, either as dividends (property
income) or as CG, depending on whether or not the corporate profits are distributed
Dividends received by corporations
oDividends paid by 1 corporation to another is included in NITP when they are received
oNITP – (special deductions: dividends from Canadian corporations) = Taxable income
oDividends paid by Crop 1 is not taxable to the shareholder: Corp 2
oDividends received by Canadian corp from a foreign corp are excluded from taxable
income if the foreign corp = foreign affiliate
Foreign affiliate of a Canadian corp if owners equity % in the foreign corp is not
less than 10%
Dividends received by individuals
oDividends earned by an individual on investments in taxable Canadian corporate
shares= in individual’s NITP
oDividends received from Canadian private crop= grossed up to include 118% or 138% of
the dividends depending on the source of the corp’s income
118%= non-eligible dividends
138%= eligible dividends
oGrossed up b/c they reflect the corporate taxes already paid by the corp on its income
Grossed up dividends= pre-tax income earned by the corp that has been
distributed as dividends
oIndividual shareholders use their own tax on the same corporate earnings (grossed up)
by applying the individual tax rate to income = at this point corporate earnings is taxed
oIndividual tax on the grossed up dividend is then reduced by the corporate tax that has
been already paid on the income
This is “Dividend tax credit” = more/less equal to the gross-up b/c it reflects the
corporate taxes that have been paid
oEliminates double taxation
oWhen corporate tax is greater= dividend tax credit is not sufficient and some double
taxation occurs
oIndividuals receiving dividends from foreign corp= not subjected to gross-up and
dividend tax credit
Actual amt of dividends from foreign corp (b4 withholding taxes) is included in
income in the year received
Stock dividends
oForced reinvestment of dividend returns in the capital shares of the corp
oAny gains/loss on their disposition= determined according to the normal capital gain
- Rental Income
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